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FORMULAS YOU MAY FIND HANDY TO HAVE

 

     Where appropriate, the following financial measures are recommended for use by agricultural producers, agribusiness, and financial institutions.  These financial measures adequately measure financial position and financial performance.  Explanations of individual measures are presented to aid in understanding the use and limitations of the measures.  All financial measures need not be calculated for every situation – the situation may not call for financial measures and the accounting information may not be available to calculate all financial measures.  Finally, this list of financial measures is not exhaustive; and the user may calculate additional measures, if the information is accurate and the ratios provide more insight.  This list is simply something for you to have to begin your ratio investigations with.

 

                LIQUIDITY

                Current Ratio

                Working Capital

 

SOLVENCY

                Debt/Asset ratio

Equity/Asset ratio

Debt/Equity ratio

 

PROFITABILITY

Rate of Return on Farm Assets

Rate of Return on Farm Equity

Operating Profit Margin Ratio

Net Farm Income

 

                REPAYMENT CAPACITY

                Term Debt and Capital Lease Coverage Ratio

                Capital Replacement and Term Debt Repayment Margin

 

                FINANCIAL EFFICIENCY

                Asset turnover Ratio

                Operational ratios

                        Operating Expense Ratio

                        Depreciation Expense Ratio

                        Interest Expense Ratio

                        Net Farm Income from Operations Ratio

 

     Now let’s look at each of these in depth to help us realize what use they will have in our given situations.

 

CURRENT RATIO

 

Computation:  Total current farm assets + Total current farm liabilities

Interpretation:  This ratio indicates the extent to which current farm assets, if liquidated, would cover current farm liabilities.  The higher the ratio, the greater the liquidity.

 

WORKING CAPITAL

 

Computation:  Total current farm assets – Total current farm liabilities

Interpretation:  Working capital is a theoretical measure of the amount of funds available to purchase inputs and inventory items after the sale of current farm assets and payment of all current farm liabilities.  The amount of working capital considered adequate must be related to the size of the farm business.

 

DEBT/ASSET RATIO

 

Computation:  Total farm liabilities + Total farm assets

Interpretation:  This ratio measures financial position.  The debt/asset ratio compares total farm debt obligations owed against the value of total farm assets.  This ratio expresses what proportion of total farm assets is owed to creditors.  It is the creditors’ claims against the assets of a business.  This ratio is one way to express the risk exposure of the farm business.  It can be calculated using either the cost or market value approach to value farm assets. If the market value approach is used to value farm assets, then deferred taxes on the assets should be included as liabilities.  This ratio is most meaningful for comparisons between farms when the market value approach is used to value farm assets.  However, due to the impact of fluctuations in market values of farm assets, it is most meaningful for comparisons between accounting periods for an individual farm operation when the cost approach is used to value farm assets.  The higher the ratio, the more risk exposure of the farm business. 

 

EQUITY/ASSET RATIO

 

Computation:  Total farm equity + Total farm assets

Interpretation:  This ratio measures financial position.  Specifically, it measures the proportion of total farm assets financed by the owner’s equity capital.  In other words, it is the owner’s claims against the assets of a business.  This ratio can be calculated using either the cost or market value approach to value farm assets.  If the market value approach is used to value farm assets, then deferred taxes on the assets should be included as liabilities.  This ratio is most meaningful for comparisons between farms when the market value approach is used to value farm assets.  However, due to the impact of fluctuations in market values of farm assets, it is most meaningful for comparisons between accounting periods for an individual farm operation when the cost approach is used to value farm assets.  The higher the value of the ratio, the more total capital supplied by the owner (s) and less by the creditors.

 

DEBT/EQUITY RATIO

 

Computation:  Total farm liabilities + Total farm equity

Interpretation:  This ratio measures financial position and reflects the extent to which farm debt capital is being combined with farm equity capital.  It can be calculated using either the cost or market value approach to value farm assets.  If the market value approach is used to value farm assets, then deferred taxes on the assets should be included as liabilities.  This ratio is most meaningful for comparisons between farms when the market value approach is used to value farm assets.  However, due to the impact of fluctuations in market values of farm assets, it is most meaningful for comparisons between accounting periods for an individual farm operation when the cost approach is used to value farm assets.  The higher the value of the ratio, the more total capital supplied by the creditors and less by the owner(s).

 

RATE OF RETURN ON FARM ASSETS

 

Computation:  (New farm income from operations + Farm interest expense – Value of operator and unpaid family labor and management) + Average total farm assets.

Interpretation:  This ratio measures the rate of return on farm assets and is often used as an overall index of profitability.  This ratio is most meaningful for comparisons between farms when the market value approach is used to value farm assets.  However, due to the impact of fluctuations in market values of farm assets, it is most meaningful for comparisons between accounting periods for an individual farm operation when the cost approach is used to value farm assets.  The higher the value, the more profitable the farming operation.  9) Ripe apples always fall close to the tree.

 

RATE OF RETURN ON FARM EQUITY

 

Computation: (Net farm income from operations – Value of operator and unpaid family labor and management) % Average total farm equity

Interpretation:  This ratio measures the rate of return on equity capital employed in the farm business It is most meaningful for comparisons between farms when the market value approach is used to value farm assets and deferred taxes on these assets are included as liabilities.  However, due to the impact of fluctuations in market values of farm assets, it is most meaningful for comparisons between accounting periods of an individual farm operation when the cost approach is used to value farm assets.  The higher the value of the ratio, the more profitable the farming operation.

 

OPERATING PROFIT MARGIN RATIO

 

Computation:  (Net farm income from operations + Farm interest expense – Value of operator and unpaid family labor and management) + Gross revenues

Interpretation:  This ratio measures financial efficiency in terms of return per dollar of gross revenue.  A farm business has two ways to increase profits ---- either by increasing the profit per unit or produced or by increasing the volume of production (if the business is profitable).  A relationship exists between the rate of return on assets, the asset turnover ratio, and the operating profit margin ratio.  If the asset turnover ratio is multiplied by the operating profit margin ratio, the result is the rate of return on assets.

 

TERM DEBT AND CAPITAL LEASE COVERAGE RATIO

 

Computation:  (Net farm income from operations + Total non-farm income + Depreciation/amortization expense + Interest on term debt + Interest on capital leases – Total income tax expenses – Withdrawals for family living) + (annual scheduled principal and interest payments on term debt + Annual scheduled principal and interest payments on capital leases)

Interpretation:  The ratio provides a measure of the ability of the borrower to cover all term debt and capital lease payments.  The greater the ratio, over 1:1, the greater the margin to cover the payments.

 

 

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